PDF Summary:Innovation and Entrepreneurship, by Peter F. Drucker

All business methods, technologies, and consumer products grow obsolete and are replaced by something new. Innovation is the process of discovering those new ways of living, working, and doing business, and entrepreneurs are the people who work to bring the future into being. In Innovation and Entrepreneurship, Peter F. Drucker describes innovation as a methodical process to find ways to improve every aspect of business and life.

Drucker is widely regarded as one of the most influential thinkers in the field of modern management. In this guide, we’ll describe Drucker’s template for structuring an entrepreneurial organization and how to explore innovative opportunities. We'll go over strategies for bringing innovations to the market and discuss how to manage entrepreneurial startups. We’ll also examine how Drucker’s ideas carry forward into the 21st century, and we’ll compare how Drucker’s thoughts on innovation compare to those of business leaders today.

(continued)...

(Shortform note: The flawed assumptions that lead to business failures—and that Drucker highlights as doors to innovation—could be more common and deeper than you think. In Alchemy, Rory Sutherland argues that all contemporary economic theories are flawed when they hinge on reason to predict human behavior. For instance, much of market research—such as a standard customer survey—rests on the assumption that people know the reasons behind their decisions, while their true motivations may be irrational and unconscious. According to Sutherland, the key to innovation is to identify consumers’ unconscious drives and use them to claim a novel stake in the market.)

The Mismatch and the Missing Link

The lesson to be learned from successes and failures is that opportunities to innovate can be found in the discrepancies between how things are and how people think they ought to be. In particular, Drucker emphasizes mismatches in economic assumptions, customer value perceptions, and inefficient industrial processes as fertile ground for innovators.

First, Drucker states that economic realities that defy long-held assumptions are powerful indicators of innovation opportunities. For instance, when increasing demand for a product fails to translate into higher profits, it signals a disconnect between conventional wisdom and market forces. Mismatches between assumptions and reality often stem from deeply ingrained industry practices that have gone unchallenged for many years. Such discrepancies create openings for innovators to disrupt the status quo by introducing more effective practices. However, Drucker emphasizes that to successfully capitalize on these opportunities requires that solutions be supported by readily available technology to increase their ease of adoption.

(Shortform note: To recognize and overturn erroneous assumptions in search of Drucker’s potential innovations is hard because it requires diving into the complexities of the market and questioning many of your accepted beliefs. In Freakonomics, Steven D. Levitt and Stephen J. Dubner assert that many cherished beliefs aren’t supported by data, but instead are reinforced by anecdotal evidence, making them seem more reliable than they are. Furthermore, those beliefs are often propagated by “experts,” who, despite their seeming authority, are just as misled by assumptions as the rest of us. Levitt and Dubner write that to accurately understand the world, you have to fight your own assumptions with rigorous data analysis.)

Another avenue for innovation stems from the disconnect between how a business values its product and the actual values that drive its customers. Drucker points out that a product’s users may be seeking to fulfill entirely different needs than those envisioned by its creators. Savvy innovators will reframe their question from "What is our product?" to "What do people need from our product?" Pricing and positioning your products in the market based on what the customer wants to buy, rather than what the manufacturer wants to sell, unlocks a way to bridge this difference in values and create an entirely new market for a product.

(Shortform note: The innovators who spot this particular mismatch are more likely to be the salespeople on the front line rather than the business managers Drucker is writing for. In The Little Red Book of Selling, Jeffrey Gitomer advises sales representatives to understand why people buy their product so they can capitalize on specific customer desires. The reasons that Gitomer lists behind many customer decisions include trust in the sales rep, a certain value in the product or service they’re buying, and things that distinguish a company from its competitors. Identifying the specific reasons why some salespeople are more successful than others can help managers identify innovations they can make to the overall business line.)

Opportunities in Bottlenecks

The final productive “mismatches” Drucker addresses are inefficiencies in established industrial processes that can serve as grounds for innovation. When a particular step in an industrial chain acts as a bottleneck that disrupts the flow of a common process, it signals a need for improvement via innovation. These process “missing links” are often widely acknowledged within an industry, but have nevertheless gone unaddressed. Resolving such issues may require new fields of research or technological inventions, but by methodically analyzing industrial processes and pinpointing areas of friction, a business can introduce improvements that streamline operations and unlock higher levels of productivity.

(Shortform note: Innovations to resolve Drucker’s “process mismatches” may be organizational rather than technical. In The Goal, Eliyahu M. Goldratt goes into detail about bottlenecks in production and how to fix them. While some issues may point to mechanical inefficiency, other reasons for a process mismatch may be endemic to a workflow’s design, how many staff it needs, or how long a piece of equipment can run. Goldratt’s solutions—and targets for innovation—include inventing ways to redirect workflow around the bottleneck, reorganizing production teams and staffing around what the bottleneck requires, and making changes to the production process so that work arrives at the bottleneck no faster than it can handle.)

Changes in Markets, People, and Perceptions

The previous opportunities for innovation all occur within an industry or between that industry and its consumers. The next set of signals that innovation is needed—and will likely be successful—stem from changes outside your organization’s sphere of control. Specifically, Drucker writes that entrepreneurs ought to keep a keen eye on market shifts, demographic changes, and the evolution of public perception.

Entrepreneurs should always watch for changes in a market or industry. Drucker explains that when the basic elements of a market start to shift, larger companies that are set in their ways often struggle to adapt, creating an opening for creative thinkers. This is especially true when industries experience rapid growth, which usually signals an impending structural shift in that industry as a whole. For instance, the auto industry’s rapid expansion in the 20th century gave birth to the “Big Three” US automakers—Ford, GM, and Chrysler. However, with demand still on the rise in the turbulent 1960s and ’70s, the Big Three failed to adapt soon enough, opening the door for foreign automakers to introduce less costly and more fuel-efficient cars.

(Shortform note: A dramatic modern example of Drucker’s principle has been the shift from physical media to digital streaming, which upended the entertainment industry’s prior business model, opening opportunities for independent artists. By shifting power away from traditional outlets such as broadcast networks, streaming platforms opened avenues for a diversity of niche content, which data-driven algorithms let these platforms curate for specific audiences. As innovators, independent filmmakers can adapt more quickly than big corporations to the shifting media landscape, but success isn’t guaranteed. As the economic turmoil caused by these changes subsides, the power may be shifting back from niche creators to large conglomerates.)

Demographic shifts also pave the way for innovation, since they provide a broad indication of who will be spending money and on what. Fluctuations in the population’s average age or education level can give you a glimpse into the future pool of consumers. Drucker writes that contrary to what some business leaders believe, these changes don't always occur slowly—in the 20th century, demographic changes happened quickly, such as the famous post-World War II “baby boom.” The key lies in interpreting how and when these changes will affect consumer behavior. By keeping an eye out for major demographic shifts, you can design new products and services for markets as they emerge.

(Shortform note: Drucker’s observations beg the question of what demographic shifts taking place now are going to affect businesses in the future. At the time of this writing, two key statistics show that an increase in human longevity coupled with falling fertility rates is leading to an aging global workforce. Older individuals are extending their careers, while still facing issues such as age discrimination in the workplace. At the same time, companies are reporting a talent shortage since they tend to recruit from younger demographic cohorts. Therefore, one might assume Drucker would suggest seeking an innovative way to recruit and engage the aging members of the workforce while making optimal use of their experience and skills.)

Perception Determines Reality

Not only do demographic changes open avenues for innovation, but so do changes in public perception. Drucker cites the example of the health care industry—despite its improvements throughout the 20th century, public opinion shifted toward its shortcomings, fueling a market for health foods and exercise. Public perception often depends not just on the facts but what people believe, both about themselves and the things they buy. Timing is crucial when banking on such changes—moving slowly can be deadly, but moving too soon might hook your business into short-term fads. When navigating this tricky terrain, Drucker says you should aim to be first in the market but make sure your innovation is small and specific, thereby reducing your risk.

(Shortform note: Though Drucker presents public perception, as in the health care example, as a factor that can trigger the need for innovation, manipulating public perception can itself be a powerful innovation tool. In Nudge, Richard H. Thaler and Cass R. Sunstein suggest that you can alter public perception by presenting people with strategically designed options. For instance, if you create a “loyalty program” for consumers —shifting their perception so they self-identify as loyal customers of your business—you reframe their decision from whether to shop at your store to what they’ll buy. Finding innovative ways to use this technique doesn’t remove people’s freedom of choice—it’s simply a tool of persuasion that’s based on understanding how people think.)

Pure Invention

The final innovation strategy—and one that Drucker doesn’t actually endorse—is that of innovation purely from scratch. Drucker objects to the romanticized notion of genius inventors and their groundbreaking products. Launching totally new inventions is highly risky and usually depends on the convergence of multiple factors in the market—a single missing ingredient may delay or derail your product's success.

According to Drucker, breaking into the market with brand-new inventions is a losing game—for each success, there are countless failures, and predicting which invention will take off is a near-impossible task. As alluring as they may seem, new inventions carry higher risks compared to other types of innovation opportunities, as well as very long development periods from concept to application, followed by another lag from development to market entry, with a total average time in development spanning 30 years for a single invention to grow into wide acceptance by the public.

(Shortform note: Drucker’s assertion that inventions by themselves don’t make for successful innovations is an idea shared by investor Warren Buffett, who famously predicted that the vast majority of internet startup companies would crash in the 1990s. Buffett points to the history of technological progress—any time a new invention hits the market, even ones that are widely accepted by the public, so many companies will flood the market that it’s impossible to predict which handful will still be alive once the initial competition phase is over. Even though the stock market tends to overvalue businesses driven by invention, the market of real goods and services inevitably corrects the stock price, losing investors—and innovators—lots of money.)

Furthermore, Drucker points out that innovation through invention rarely hinges on a single new development—instead, it commonly depends on the union of two or more technologies or practices. For instance, even though cathode ray tubes (CRTs) were invented in 1897, it wasn’t until Philo Farnsworth leveraged the newly discovered “photoelectric effect” that he could build the first CRT-based television. Therefore, until every piece of the puzzle is ready, an innovation isn’t ripe for deployment. It follows, then, that your first step must be to analyze everything that needs to exist for your invention to succeed. Not doing so can result in a misfire—either your innovation will bomb, or a competitor will swoop in and seize the advantage after you fumble.

(Shortform note: Not everyone agrees with Drucker’s cautious approach to invention. For instance, in Walter Isaacson’s biography of Steve Jobs, he writes that the Apple founder believed that invention has to come before the market knows what it wants. Jobs’s approach to innovation relied on his intuition to see possibilities others missed. Jobs wasn’t a perfect oracle, but when his intuition misstepped, he’d just take the next leap ahead. However, he was canny enough to spot the convergence of technologies that Drucker describes. For example, when he introduced the iPod music player, he already knew that advances in cell phones would make the iPod obsolete—so he started work right away on his next innovation—the first iPhone.)

Bringing Innovation to the Market

Just as important as coming up with innovations is finding the right way to introduce them in the market, whether as a new product or a new way of doing business. Any market-entry strategy carries its own set of risks and rewards and requires careful planning and execution. Drucker presents three options—you can corner a brand-new market, take advantage of another innovator's mistake, or take over a narrow niche within an existing industry or marketplace.

Corner the Market

Creating a new market and cornering it immediately is an audacious yet risky move for innovators aiming to achieve market dominance. Drucker says that this technique, while widely publicized, leaves no room for error and demands flawless execution. This path is also narrow and unforgiving—success depends on careful planning and setting appropriate goals from the outset. Once your innovation yields returns, it's essential to channel all your resources into sustaining its success, but staying ahead also requires constant innovation at a faster pace than the competitors who’ll be nipping at your heels. The high risk associated with this strategy leads some entrepreneurs to base their tactics around its potential failures.

(Shortform note: Though risky, the advantage of Drucker’s first strategy is that it moves your business into a market where you can operate without competition. In Blue Ocean Strategy, W. Chan Kim and Renée Mauborgne call these markets “blue oceans,” as opposed to “red ocean” markets full of competitors in which every company’s success relies on other businesses’ failures. Kim and Mauborgne’s research shows that successful companies in uncontested markets consistently outperform companies that must actively fight off competition. However, Kim and Mauborgne admit that their numbers don’t show how many “blue ocean” companies fail completely as opposed to their “red ocean” counterparts.)

Outfox a Competitor

Drucker says that rather than trying to conquer the world, one savvy innovation strategy is to capitalize on another innovator’s missed opportunities by taking someone else's innovation and introducing it into a different market, such as retooling a business product for the home use sector. The key to success lies in understanding what customers want better than the original innovator. Unlike trying to corner the market, this strategy is less risky because it operates within an existing market where you can conduct consumer research to find out what the market leader missed. Ultimately, you aren't creating something new—your innovation is to refine what's already there and position it correctly by viewing it from a consumer’s perspective.

(Shortform note: Outmaneuvering a competitor in this way can rely more on marketing savvy than technological know-how. The authors of Ten Types of Innovation classify these as perception-related innovations. The tricks to pull this off include finding a better distribution channel for a product, establishing a way to support customers as they use it, retooling the product so that consumers enjoy it more than before, or simply finding a better way to brand it. As Drucker points out, all of these require having a better understanding of the consumer experience than the original innovator that you’re copying.)

A notable example of “outfoxing a competitor” is when Steve Jobs’s Apple Computers usurped one of Xerox’s innovations, which the latter company failed to optimize for the market. Though Drucker praises Xerox’s successful innovations in the world of business products, they famously dropped the ball on their Graphical User Interface (GUI) through which a user can control a computer by pointing and clicking on a screen with a mouse. Xerox developed its GUI interface strictly for high-end, expensive business machines, but Jobs recognized its potential to revolutionize the home computer market, and he used it as the basis for Apple’s groundbreaking Macintosh computer. Xerox’s product, on the other hand, flopped.

(Shortform note: In a corollary to the example above, Bill Gates managed to outfox Apple with Microsoft’s Windows operating system the same way that Apple had done with Xerox. Gates was such a fan of the Macintosh GUI that he petitioned Apple to license it for use on other computer systems. Jobs rejected this idea, preferring to keep his GUI exclusive to the Macintosh, but Apple’s contract with Microsoft licensed Gates to incorporate Apple design elements into Microsoft’s future products. Microsoft came out with its first Windows GUI in 1985, and because it was compatible with virtually all non-Apple home computers, Microsoft Windows completely eclipsed Apple’s share of the home computer market by the mid-1990s.)

Monopolize a Niche

As opposed to making a big splash in the general market, Drucker highlights an alternate approach—to dominate a small, specific niche within a larger process or market in a way that renders competition impractical. By creating an innovation or providing a specialized skill that's integral to another product or process, you effectively make your business indispensable. As long as the market is limited in size, potential competitors can only reduce prices at the expense of their own profits. These niches are rare and can only be discovered through dedicated research, and while they provide security, niche markets come with downsides, such as limited room for growth and a total dependence between your business and the larger market you serve.

(Shortform note: The niche markets Drucker describes are inherently static, but there are many that aren’t. In Crossing the Chasm, Geoffrey Moore recommends a strategy in which you start by occupying a narrow niche market and then building on your niche to reach different markets, growing outward from your original niche core. This approach uses the power of brand recognition and word-of-mouth within one market to open doors to another. In a sense, Moore’s strategy is a way to use Drucker’s “niche monopoly” tactic as a stepping stone to his earlier strategy of cornering a new market entirely.)

One such business that occupied a narrow niche was the Pullman Company that dominated the market for railcar sleeper services in the United States for decades. Pullman designed, built, and owned the sleeper cars that were then leased to railroads, and it also hired and managed the porters and attendants that provided customer service onboard the trains. Because it would have been too expensive for a rail company to provide all of Pullman’s services separately, they had little choice but to use Pullman cars and staff for their sleeper car operations.

(Shortform note: Drucker notes that if you secure a niche monopoly, it’s important not to abuse your position or else you’ll invite competition. Pullman suffered a blow to its public image as early as 1894, when a massive strike by Pullman workers over the issues of wages and living conditions tarnished the company’s reputation and set the stage for its slow decline. In 1943, the US government ended Pullman’s monopoly over the nation’s sleeper cars by forcing it to separate its rail car manufacturing and customer service divisions. Though Pullman had successfully created its own niche via careful innovation, its failure to recognize the fragility of its niche led to the company’s breakup and demise.)

Management for Entrepreneurial Startups

While Drucker aims most of his advice at the established corporation that needs to shed its old habits, he directs the remainder of his writing at startups. While big businesses need to learn how to innovate, the entrepreneurial startup needs to learn how to manage itself. According to Drucker, startups need to focus on four specific things: their market, financial planning, setting up a management team, and what role their founder should play in the business.

Watch the Market

Drucker writes that entrepreneurial startups must always keep a watchful eye on their markets. Innovation’s unpredictability often leads to surprise failures and successes that the startups didn't anticipate, and it's crucial to spot and seize new markets as they emerge before they fall into competitors' hands. As discussed before, with truly novel innovations, predicting the exact market is impossible. Therefore, startups should always expect that their innovation might resonate with an unforeseen market segment. Remember: Both successes and failures can serve as indicators, revealing wholly unexpected avenues for growth.

(Shortform note: While, as Drucker points out, there may be no way to predict exactly who your customers will be, a new business does have the power to shape their customers’ experience. In Raving Fans, Ken Blanchard and Sheldon Bowles write that simply meeting a customer’s expectations isn’t good enough for your startup’s survival, but if you exceed their expectations, you’ll convert customers into word-of-mouth advocates who’ll bring even more customers to your business. Just be mindful, per Drucker’s advice, that you recognize who your customers are and identify their real needs, not the ones you envisioned when you started your business.)

Watch Your Money

Drucker writes that a lack of robust financial controls can doom the most promising startups, particularly those that grow too rapidly. Many entrepreneurs fall into the trap of wanting to withdraw profits prematurely, which can starve their businesses of much-needed funds during their growth stage. Drucker insists that any "profit" made by a startup should be reinvested back into the business—anything less leads to problems down the line. Also, as your startup expands, it will outgrow its initial funding method, necessitating the addition of partners or a public offering of stock. Anticipate your future needs and set them in motion today.

(Shortform note: While it’s certainly important to manage your business’s finances, not everyone agrees with all of Drucker’s points. In Profit First, Mike Michalowicz suggests that entrepreneurs shouldn’t reinvest all their money back into their expenses, arguing that reinvestment into growth makes a business unstable and reduces the amount of free cash it has on hand in case of emergencies or the need to pivot in response to changes in the market. Instead, Michalowicz says that business owners should claim their profits first, thereby limiting the funds available to expand their business and forcing them to spend it more wisely. His approach forces a startup to focus on efficient spending rather than the pursuit of runaway growth.)

Establish a Management Team

Drucker says that after you make your startup’s financial plan, the next step is to set up a management team. The reason is simple—if successful, a startup cannot be run by the founder alone indefinitely, and you have to prepare for this transition before managing the business reaches a crisis point. As a general guideline, if it looks like your startup might double in size over the next four years, it's time to start shifting the management structure. This process should begin informally, allowing each potential member of your management team to reflect on what they have to contribute while learning how to work with each other. Then, when you need a management team, you already have one in place.

(Shortform note: The management structure Drucker recommends is a fairly traditional hierarchy, but there are different options available. In Reinventing Organizations, Frédéric Laloux describes an emerging form of organizational structure in which workers are mutually supportive, yet largely self-managing. In this new style of organization, individuals have roles instead of strictly defined titles, and management’s place is to advise the group instead of leading by mandates and directives. Laloux writes that it’s hard to convert a long-established business to this new mode of thinking—it’s easier to set self-management in place in the initial organizing phase that Drucker says must be addressed as soon as a business starts to grow.)

Determine Your Founder’s Role

Creating a management team begs the question, “What will the startup’s original founder do?” The original entrepreneur must make sure that their ego doesn't hinder the business. Founders who insist on maintaining absolute control often drive their businesses into the ground. Therefore, founders need to reflect on several key questions: “What does the business need going forward? Which of those needs can I effectively address? What role do I genuinely want to play in this company—or do I even want to be a part of it at all?” Sometimes, the answers lead entrepreneurs to realize they'd rather step away from day-to-day management and find a niche where they can contribute while letting someone else make the big decisions.

(Shortform note: Not infrequently, founders who don’t follow Drucker’s advice to reassess their roles as their companies grow may find themselves ousted by their own investors. The problem is that the skills and strategies that worked to run their business in its early stages might not suit an evolving company. Especially if the founder is overconfident about their leadership abilities or their impact on the business's growth, they might even resist much-needed changes to keep their company afloat. In the long run, not reevaluating the founder’s position within their own business could threaten both their livelihood and their company’s future.)